Acclaro Partners' Research and Strategy Weblog

The Economy's Impact on M&A in 2011

Five core constraints served to inhibit economic growth over the past two-and-a-half years.  Today there are five signs of improvements in the economy.  As conditions continue to improve, M&A activity is sure to follow.  2011 should be a relatively good year for M&A. 

The Harsh Realities of the Past

The five major economic constraints are fairly obvious in hindsight.  The five are all related.  And they all seem to stem directly or indirectly from the mortgage fiasco.  Housing price increases no longer generate cash for investors and home owners.  In fact, the values of real estate have declined precipitously (to more rational levels) and created upside down mortgages and foreclosures, and generally made it more difficult for homeowners to reap the benefits of home ownership. 

A secondary, though related, factor has been the financial/banking crisis and related credit availability.  The banking and credit crisis indirectly or directly led to other constraints.

Third is the unemployment level, which has hovered at around ten percent.  However, when one factors in the “under-employed” and those that have simply ceased looking for work, the figures are actually closer to twenty percent. 

A fourth constraint on economic growth is a side-effect of unemployment – consumer confidence. 

In addition to consumer confidence, business confidence, in the form of capital investment in equipment and structures used to produce goods and services, declined rapidly.

By no means a comprehensive list, these factors serve as the top five inhibitors of economic growth over the past couple of years.

The Positive Signs of the Present

As of September, 2010, there are some positive signs of recovery.  GDP growth has averaged 3.5% since mid-2009.

There has been the creation of more than half a million private sector jobs.  Granted, unemployment still stands at roughly ten percent, but we are creating some new jobs.  New jobless claims have declined.  Some companies are tapping temporary workers to help meet increasing demand.

Third, the Fed seems likely to allow interest rates to remain near zero in the foreseeable future.  Low interest rates are helping to stabilize the economy by keeping credit card interest rates, mortgages and other loan rates low.

Fourth, credit appears to be thawing.  The availability of consumer and business credit again serves as a major driver of economic growth. 

In addition to more supply of credit, there is substantial pent-up demand for credit capital at this time.  There is a backlog of refinancing requests, there are increases in corporate borrowing due to increasing business confidence and interest in capital expenditures, and there is a significant amount of “dry powder” – equity investments in private equity funds that are yet to be deployed.  When this equity is employed, private equity groups almost always borrow capital to complete the transaction (they invest only a percentage of equity in the deal and borrow the rest in much the same way that consumers put equity downpayments on a new house and pay for the balance with a loan).

Middle Market M&A Potential in 2011

The middle market has finally started to benefit from increased confidence of the credit markets.  Lower borrowing costs, more available credit, less stringent covenants – these are all facilitating increased access to capital for acquisitions.  And experts expect that a significant level of demand for asset-based lending will spark an increase in supply of this form of credit by 2011.  Moreover, both second-lien and mezzanine financing are also expected to be strong performers in 2011. 

Both troubled and performing companies alike are now more open to the concept of an M&A solution, as they recognize that there is a stronger possibility of actually getting a deal closed. 

Economic stability has enabled business owners to improve upon the reliability of their forecasts, which helps buyers become more comfortable with the businesses, and ultimately, gives them greater confidence to pay higher multiples of earnings. 

Both deal volume and deal value are demonstrating strong growth in the year-over-year trailing twelve month periods.   And the trend is likely to continue.

Private equity firms may have as much as $450 billion in cash sitting on the sidelines.  They raised this cash during the boom years and now have only a short period of time before they must spend it, or give it back to investors.   Through the first half of 2010, there have been 672 acquisitions by private equity firms with a deal value totaling about $50 billion. In 2009, there were 508 transactions, totaling about $35 billion.

And strategic buyers have cash reserves, and are putting that cash to work. 

The right ingredients are in place to create a strong year in 2011 for M&A activity.

Conclusion

As we analyze the harsh realities of the past, and compare those trends to today’s market realities, it becomes evident that we are on track to see expanding economies and ultimately, increased M&A activity.  The big question marks concern unemployment levels and related consumer confidence.

Christopher “Kit” Lisle is the Managing Partner with Acclaro Growth Partners, a research-based management advisory firm located in the Washington, DC area.  Acclaro supports private equity groups and corporations with market research and strategy consulting activities.  For more information about Acclaro, click here.

INDUSTRY EXPERTS VS. GENERALIST CONSULTANTS – THE BATTLE FOR MARKET DUE DILIGENCE

The following post includes five presumed benefits of working with industry experts, and the five realities associated with these presumptions. 

 

Presumed Benefit #1:  Industry Experts have all the Necessary Information Readily Available	Reality #1:  Most Industry Experts Conduct Very Little Research; They Have Opinions
Presumed Benefit #2:  The Expert Opinion Must be the Correct Opinion	Reality #2:  Private equity investors forget that their investments are typically in very obscure, niche sub-sectors.  Industry experts cannot focus on narrow, shallow industries because there would not be enough demand for their services.
Presumed Benefit #3: Industry Experts are Quicker than Generalist Consultants	Reality #3:  Industry Experts Are Quick to Opine but Very Slow to Write a Cogent Report
Presumed Benefit #4:  Industry Experts Are Inexpensive	Reality #4:  You Get What You Pay For
Presumed Benefit #5:  Industry Experts Offer Options and Recommendations	Reality #5: Industry Expert Feedback is Rarely Actionable Board Level Feedback

 

Conclusion

Those considering hiring industry expert consultants should consider asking them five questions before doing so:

1.    Will you be conducting any real-time research during this project, or will the project be based purely on opinion?

2.    What are the backgrounds of your experts in the specific niche sector of interest?

3.    What is the timeline before we will receive a written report?

4.    What is the complete cost of the study?

5.    Will you be able to offer analysis, options, and recommendations that would impact our acquisition decision and the positioning of the Company going forward?

Based on the answers to these five questions, hiring an industry expert may make sense for your firm in a particular instance.  However, research-based generalist consultants with a “clean slate” approach are typically more thorough, provide more detailed quantitative and qualitative insights, create more user-friendly reports, offer actionable recommendations, and generally represent a better overall value.

Primary Research for Private Equity

 

Private equity groups are hiring research and consulting firms to conduct primary research with increasing frequency.  For those considering this trend or unfamiliar with third party primary research, it makes sense to describe what primary research is, how and why it works, who does it, and what to look for in hiring a firm providing primary research. 

For Acclaro Growth Partners, primary research means candid, direct, person-to-person phone conversations with a wide range of industry experts in four vantage points of the industry:  suppliers, competitors, third party experts (e.g., associations and industry expert consultants), and customers.  

The best primary researchers are “Renaissance” men and women.  They are knowledgeable about a wide range of subjects and are able to carry on conversations fluently, with interest, and in a way that generates enthusiasm from the conversational participant.  Analysts build rapport with phone contacts and develop meaningful, interesting, and mutually useful conversations with their contacts.

 

Primary researchers typically rely on one or more of several motivators.  People talk with researchers for the following reasons:

· To satisfy their own egos (“I know more than this consultant.  I am the expert.”)

· To enjoy playing the role of coach or teacher (“You have it all wrong; let me explain what is really going on.”)

· To satisfy their own curiosity and need for intelligence (“This researcher knows more than I do; maybe I could learn something here.”)

· To help the researcher out (“You are under a deadline and you know nothing about this space?  Let me help you out for a minute.”)

 

The process involves a multi-step process for jump-starting a conversation from scratch:

· Introduction – Primary researchers must identify themselves by name and by the name of their company.

· Explanation – The reason for the call.  Primary researchers must tell the truth, but not necessarily the whole truth.  For example, they could say they are studying the industry (but not hone in on the specific niche segment of interest).  They could say they are doing market research (but not mention an acquisition).

· Hook – The interesting trend, dynamic, threat, opportunity, or other popular topic of conversation facing the industry.  The researcher may mention that they have heard the opposite of what is actually occurring, or may compare trends in this country to those in another country, or may simply share the insights he has gathered.  The point is to say just enough that the person on the other end of the phone simply cannot resist responding.

· Steer the conversation – By asking follow-up questions to what the other party has already said, the researcher covers a lot of ground without appearing to be working off of a script.  The real answer to any problem is usually two or three questions deep.

 

The telephone conversations Acclaro conducts are useful because they are:

· Interactive – you can ask follow-up questions in response to what the contact has already said.

· Direct – you go straight to the horse’s mouth.

· Precise – you get the exact answer you need – faster and more reliably than through other means.

· Inexpensive – solid answers for the cost of a phone call.

· Recent – you may not be able to read about a very recent development in the industry, but you can ask about it.

 

There are four suggestions of capabilities or philosophies to look for in a primary research vendor:

· Experienced researchers – a team that has been conducting primary research for years and is not fresh out of college.

· Blind approach – eliminate the biases that exist when the contact knows which organization you are studying, or the identity of the client.

· Collaborative, interactive approach – to avoid having the research head off in the wrong direction mid-project.

· Actionability – Instead of a data dump, the research should lead to intelligence, which leads to analysis, which leads to options, and finally, a recommendation.

 

To learn more about our capabilities, visit our website

Human Capital Assessments

Acclaro Growth Partners conducts market, competitive, customer, operations, and management research.  Our management assessment is an analysis of the management team, and the team’s working dynamics.  An organization is only as strong or weak as its management team.  Management assessments are effective in providing input on the strength of the human capital in your organization. 

Why conduct a management assessment?  One reason to conduct a management assessment is to augment due diligence activities.  In purchasing a company, it is important to look at three legs of the stool: financial, market, and management.  If only two legs are strong, the stool may not be able to withstand the pressure, and may tip over.  Savvy investors do not accept at face value what management says about the financials or the marketplace.  These investors also take the time to assess management.  Other reasons to evaluate the management team involve restructurings and management changes, changes in corporate strategy, and in situations in which there is a significant problem (declining revenues) and no clues as to the root cause of the problem.

How do we conduct the management assessment?  Our team is comprised of partners who have worked for large corporations.  They have overseen rapid corporate growth and have nurtured start-ups into stable and profitable entities.  They are skilled in conducting in-depth, targeted interviews designed to elicit critical information.  The interviews are semi-structured to prompt frank, candid, open conversations.  A team approach is typically utilized.  Optionally, there are personality inventories which may be utilized to provide greater insight into the team dynamic and individual styles.

What are some of the typical issues that are discovered during the assessment?  Below is a list of issues that we often uncover in our assessments:

· Organizational structure – Is there a pattern of shared values and beliefs that provides members of the organization with meaning and rules for behavior?

· Culture – Are people, work processes, and resources deployed to achieve organizational goals effectively?

· Talent acquisition and feedback – Does the company attract and retain exceptional talent?

· Performance feedback – Is there a systematic or structured process to set performance expectations and provide feedback on a consistent basis?

· Communications – Is there a system in place to provide employees with timely information about business performance, plans, and strategies, in order to make good suggestions for improving the business and to cooperate in major organizational changes?

· Training and development – Does the company invest in improving the technical and managerial competencies of its employees?

· Compensation – Is there a corporate pay philosophy that rewards performance, and that employees perceive to be equitable?

· Leadership capability – Does the core management team have the requisite breadth of experience to understand its market and manage the company to the next level of growth?  Does the leadership style motivate employees to work toward the company’s strategic goals?  How deep into the organization does the leadership capability permeate?  Does management operate with integrity and ethics?

· Dynamics of power – Who really controls what happens in the organization?  How are power and politics used in the organization – self-serving obstacles to success, or pathways to effective decisions?

· Decision-making process – Are decision made by an individual or a group?  How is information collected and distributed?  How long does it take for decisions to be made?

· Human capital investments – To what extent has the organization considered the importance of policies, processes, and procedures that foster growth and development of existing employees?

· Vision – Are there organizational leaders with clear visions of the future?  Are these visions aligned?

Management assessments can reveal the answers to all of these questions.  More importantly, they can help focus the efforts of the board.  Which areas require immediate attention, and which are concerns that can wait?  Consider a human capital assessment for your organization or acquisition target.

For more information on human capital, click here

Competitive Intelligence for Private Equity Portfolio Companies

Over the past couple of months, Acclaro has fielded several inquiries from private equity groups curious about what can be learned about competitors’ operations. 

Competing in niche industries with few or no public companies as proxies and limited published market data, portfolio companies must operate somewhat blindly in their industry segments.  However, some private equity groups have encouraged their portfolio companies to utilize competitve intelligence practitioners.  They do so to augment their internal understanding of the competitive landscape, competitor capabilities, and most importantly, competitor intentions.

Most private equity portfolio companies have a narrow and shallow understanding of their competitors.  Those subject areas they do understand about competitors (e.g., revenue, product line, and core strengths and weaknesses) do not extend deeply into a range of finance, product or corporate strategy issues.

A one-time review of the competitive landscape is not enough.  The functional understanding described in this white paper can certainly not be achieved in one study.  The portfolio company needs to build up a baseline understanding, with help from a third-party consulting firm with expertise in competitive intelligence.  This baseline understanding should be updated annually, probing both more deeply into known areas, and broadly into areas that are not yet understood.  Over time, a portfolio company will be able to anticipate competitor’s moves and make bold decisions understanding in advance how the competitors will or will not respond.

 

 

The Increasing Importance of Market Due Diligence

Market due diligence, often the most critical aspect of diligence, is becoming even more important. The risks of doing deals are higher than they have been in recent memory.  Drivers (related to lender interest in market data, the need for industry/sector attractiveness assessments, the demand for analysis of the target’s attractiveness/positioning, equity vs. debt allocations, and other issues) are making buyers even more apt to utilize outsourced market due diligence.

Unlike other aspects of due diligence, market due diligence does not base its findings on information provided by the company.  Instead, market due diligence involves gathering data from industry experts, competitors, customers, and sometimes suppliers and other third-party market participants.  In niche markets, it is essential to gain the perspective not only of customers, lost accounts and prospects, but third party market experts, and, most importantly, direct and indirect competitors.

Market due diligence therefore provides a “more accurate, independent, future-centric, and ultimately more reliable view of the…prospects of the business.”  (“Counsel: Commercial Due Diligence and Acquisitions,” The Edge Malaysia, Issue 759, Marcus van Geyzel, June 15, 2009).

While those involved in M&A seem to hear more about financial and legal due diligence, “the core of every transaction” is the market due diligence.  “Financial and legal aspects are only tools necessary to complete the transaction.” (KPMG Benchmarking Study – Internal Commercial Due Diligence, February 2009).  Market insights are the most critical aspect of all due diligence because they are not only helpful in facilitating a Go/No Go decision on the deal, they are also instructive in pointing out a strategic direction for the newly acquired target, post-closing.  The ability to gain access to a vast array of market experts (customers, competitors, third-party market participants) is one of the key benefits of outsourcing market due diligence.

 To learn more, click here.

Private Equity is Destined to Remain a Viable Option for Middle Market Sellers

Doom and gloom.  It is everywhere.  Articles are cropping up questioning the viability of private equity.  There are at least seven simple reasons that private equity will blossom over the next several years, or at least segments of it.

1.  Influx of Capital -- With the stock market unlikely to serve as a promising source of returns over the next year or two, private equity will continue to serve a strong role as an alternative investment.

2.  Restructuring of Private Equity firms -- PE firms are becoming more specialized to serve the unique needs of "special situations," industry segments, geographic regions, and they are bringing on more experienced operating partners to ensure they can add value post transaction.

3.  Transfer of ownership of middle market companies -- As aging baby boomers continue to reach retirement age, they will seek options for the sale of their business.

4.  The IPO route is less attractive -- Sellers generally have three options.  Sell to strategics, private equity groups, or go public.  With public company valuations down, the IPO route looks less attractive today than in the recent past.

5. Strategic acquirers may be gun shy -- Competition for acquisitions may be less intense than has been expected with strategic acquirers, who are concerned with the internal efficiencies of their own operations.

6.  Some private equity groups have unique access to debt  -- They use different names to describe themselves, but there are a number of funds that have internal access to debt and equity.  They see the lack of access to credit as an opportunity to get deals done quickly, with limited competition, and at great bargains.

7.  Private equity continues to add value to companies struggling to grow or become more profitable -- The rise of operating partners in funds, internal operational improvement consultants, the enhanced role of due diligence leading to 100 day plans, and the increasing role of consultants in private equity -- These are all signs that the industry is placing more value on actively improving the health of the businesses it invests in.

Private equity, at least some segments of it, will actually do quite well over the next couple of years.

What Will Be the Impact of the Financial Crisis on Private Equity?

Private equity investments are down sharply.  That’s no surpise.  But they are down in proportion to overall M&A activity, which means that strategic acquisitions are increasing.  Strategics can often offer stock, and public companies may now be better able to secure debt than private equity groups.  So, what is the longer term forecast for private equity?

The deepening credit crisis obviously makes it more difficult and potentially more expensive to borrow capital.  But it may also make it harder to pay back borrowed money.  The worsening general economic conditions are reducing the values of portfolio companies.  As private equity groups spend more time and energy on these portfolio companies, they will be likely need to hold onto these companies longer to generate reasonable returns.  Restructuring the portfolio companies, combining them with other companies, pursuing add-ons, and generally being more hands-on with management takes time.  Expect fewer new platform investments and longer holding periods.

Yet, despite the doom and gloom, there are new funds being formed on a daily basis.  Investors all over the world still have an appetite for US private equity investing.  Some private equity groups are positioning themselves as special situations funds and others are deciding to focus more on distressed debt investing. 

Private equity is certainly not going away.  But the landscape is changing.  The expectations are evolving.  The types of investments are morphing.  The next year, scratch that, the next couple of months should be interesting.

Acclaro Growth Partners - visit our website.